Foreign Portfolio Investment

Updated on January 29, 2024
Article byPriya Choubey
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Foreign Portfolio Investment (FPI)?

Foreign Portfolio Investment (FPI) is the practice of investing in financial assets of a country different from that of the investor. It can be any financial instrument, like stocks, bonds, Exchange-traded Funds (ETFs), marketable securities, Global Depository Receipts (GDRs), and mutual funds. An FPI helps investors capitalize on cross-border economies without directly holding the company’s assets.

Foreign Portfolio Investment

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FPI is a suitable option for retail investors interested in diversifying their portfolio by adding a foreign market component without making a significant investment. Such investments are prompted by the high returns offered by foreign companies. Moreover, most investors undertaking FPI prefer a stable economy functioning under a sound government—an economy marked by considerable industrial growth.

Key Takeaways

  • Foreign Portfolio Investment (FPI) is a passive investing strategy to buy financial assets of companies located overseas. Stocks, bonds, mutual funds, ETFs, and GDRs are common types of foreign portfolio investment.
  • Retail investors prefer FPIs to diversify their investment portfolio while maximizing returns and capital gains and maintaining liquidity.
  • Such investments are exposed to foreign market risks, including exchange rate fluctuations, political instability, and economic conditions.
  • FPI is centered on financial assets, short-term goals, and minimal control. FDI involves a long-term commitment, where the investor focuses on business control and wishes to establish their brand or company presence in a foreign country.

Foreign Portfolio Investment Explained

Foreign Portfolio Investment (FPI) involves purchasing securities in another country’s financial markets without acquiring a controlling interest in the company. It notably impacts a country’s financial markets, affecting the exchange rates, stock prices, and bond yields due to capital inflows and outflows. Governments often regulate FPI to maintain stability in their financial markets and prevent excessive volatility.

Investors opt for FPI for various reasons, such as diversifying their investment portfolios, seeking higher returns, or capitalizing on favorable economic conditions in other countries. It is vital in the global economy, as it facilitates the movement of capital across borders and contributes to the growth and liquidity of financial markets worldwide.

However, FPI introduces risks, as it exposes a country’s financial markets to external economic and political factors such as foreign exchange fluctuations, political instability, and changes in market sentiment. Also, investors should carefully assess these factors before making foreign portfolio investments.

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Factors

FPI is affected by various determinants related to the foreign market, industry, and assets. These include:

  • Economic Indicators: The overall economic condition of a country encompassing factors like GDP growth, inflation rates, and fiscal policies can attract or discourage FPI.
  • Political Stability: A stable political environment and a favorable regulatory framework are essential for attracting FPI, as political instability or frequent policy changes can dissuade investors.
  • Interest Rates: High interest rates in a country are available through FPI as investors seek better returns. Conversely, lower interest rates can deter foreign investment.
  • Exchange Rates: The stability or appreciation of the local currency can be attractive to foreign investors as it helps preserve the value of their investments when repatriated.
  • Market Liquidity: Investors typically prefer markets with high liquidity, facilitating easy entry and exit.
  • Risk Factors: The perception of political, economic, and financial risks plays a significant role. Elements like corruption, security concerns, and legal risks can discourage FPI.
  • Regulatory Requirements: Clear and transparent regulations and the protection of investor rights are critical for promoting FPI.
  • Taxation: Tax policies, including capital gains taxes and withholding tax rates on dividends, can influence investment decisions.
  • Global Economic Conditions: Global economic trends, such as shifts in interest rates or commodity prices, can affect FPI decisions.
  • Market Sentiment: Investor sentiment and market speculation can also impact FPI. Positive news or events can attract investors, while negative sentiment can lead to withdrawals.
  • Geopolitical Events: Political tensions, conflicts, or geopolitical events can create uncertainty and hamper FPIs.
  • Sector-specific Factors: FPI may be influenced by industry-specific factors, such as growth prospects and regulations within particular sectors.
  • Trade Policies: Trade policies and restrictions can impact a country’s attractiveness for foreign investment, especially in export-oriented industries.

Examples

Some examples have been discussed in this section.

Example #1

Suppose Adam, residing in Canada, invests in a US 3-year Treasury Note with a coupon rate of 4.375%. The product mitigates the risk of his overall investment portfolio and diversifies it. Moreover, Adam can sell the T-Note in the financial market anytime. This shows how such investments can benefit a retail investor from a foreign country.

Example #2

Assume Brenda, a Malaysian resident, buying stocks of a renowned UAE company on September 13, 2022, at AED 0.1680 per share. On September 05, 2023, she sells her FPI in the share market for AED 0.3600 per stock. This means she bought 1000 units and made a profit of AED 192, or 114.28%, in less than a year. This shows that retail investors can make quick gains if their investment decisions in a given period are correct.

Example #3 – United States Foreign Portfolio Investment

In March 2023, the US FPI experienced a notable increase of $6.043 billion, bouncing back from the previous quarter’s significant decline of $101.060 billion. This data, updated quarterly since March 1960, has displayed fluctuations over time, reaching an all-time high of $422.405 billion in December 2020 and hitting a record low of -$146.760 billion in September 2015.

The Bureau of Economic Analysis is the source for this crucial information on Foreign Portfolio Investment in USD. In tandem with this change, recent reports from the US indicate a current account deficit of $219.300 billion in March 2023.

Advantages And Disadvantages

Like other investment options, FPI also has some pros and cons. These have been discussed below.

Advantages

  • FPI helps investors diversify their asset basket by investing in securities from various countries and foreign industries, reducing overall risk.
  • Such assets are often more liquid than other foreign investments, facilitating easier buying and selling.
  • FPI provides access to global markets, allowing investors to benefit from the growth and performance of economies worldwide.
  • Compared to domestic investments, it offers the potential for higher returns, especially in emerging markets with robust growth prospects.
  • Investing in foreign assets can offer currency diversification, safeguarding investors from currency devaluation in the home country.

Disadvantages

  • FPI in the share market exposes investors to exchange rate fluctuations, potentially resulting in gains or losses based on foreign currency performance relative to the investor’s home currency.
  • Foreign investments can be influenced by political instability, changes in government policies, and economic conditions in the host country, increasing the risk of losses.
  • Investors have limited control over the management decisions at invested companies.
  • When researching foreign market products, investors may face difficulties accessing information due to language and cultural barriers.
  • Governments may alter FPI regulations, affecting the ability to invest or repatriate funds.
  • Investing in foreign markets can incur higher transaction costs, including currency conversion fees and taxes, potentially reducing returns.
  • Taxation of foreign investments can be complex, with potential withholding taxes and other tax obligations in the host country.

Difference Between Foreign Portfolio Investment and Foreign Direct Investment

FPI and Foreign Direct Investment (FDI) are distinct forms of international investment. Let us study the various dissimilarities between them:

BasisForeign Portfolio InvestmentForeign Direct Investment
DefinitionFPI refers to investors from a given country purchasing financial assets, such as stocks and bonds, in a foreign country.FDI is the process of making a long-term investment in a foreign country, to gain substantial control or influence over a business or an asset.
ProductsForeign portfolio investments comprise stocks, bonds, mutual funds, money market instruments, ETFs, GDRs, etc., of foreign companies.  These are direct investments in foreign businesses or assets. 
Capital RequirementThe capital needed to buy is limited to the entity investing in these foreign assets. The investment required for FDIs is high as this involves a serious financial commitment. 
Mode of InvestmentTrading on financial markets is seen here.Acquiring or establishing subsidiaries, joint ventures, or wholly owned operations in a foreign country is the investment method adopted by institutional investors.
GoalsEarning high and quick returns or capital gains is usually the goal.Strategic growth or expansion of business is the goal here. 
DiversificationDiversifies the investment portfolio of retail investors and gives them access to high-yield assets in foreign countries. Diversification across different sectors and economies makes it easy for businesses to expand their operations and reach new markets.
LiquidityThe liquidity level is high. The liquidity level is low. 
TermSuch investments are undertaken from a short-term perspective. This requires long-term vision and planning. 
ParticipationLittle to no involvement in the invested company’s management is seen in FPI.This arrangement demands active participation in business management.
ControlFPI investors do not seek significant control over the companies they invest in.FDI makes complete or maximum control over the business in which the entity has invested a primary goal. 
Suitable ForThis is suitable for retail investors with relatively low risk appetites.Business entities and institutional investors have the financial capacity and the risk appetite required for FDIs. 

Frequently Asked Questions (FAQs)

1. Who are foreign portfolio investors?

Foreign portfolio investors are passive retail investors who put their money in financial assets belonging to overseas companies, such as stocks, bonds, money market instruments, currency, etc.

2. What are the objectives of FPI?

The various purposes of FPI are:
– It diversifies the investment portfolio.
– It offers high return and capital appreciation opportunities.
– It provides liquidity to short-term investors.
– FPI helps hedge currency depreciation risks.
– It allows entities to gain insights into global market trends, access information, and develop a deeper understanding of international markets.
– FPI facilitates foreign exchange market operations.
– It helps balance capital flows between countries.

3. Which sector is prohibited in FPI?

Illegal activities like gambling, betting, lottery, and other such unlawful investment prospects are forbidden in foreign portfolio investments.

4. What is the minimum retention period for FPI?

In debt markets, foreign portfolio investors must hold the assets for at least three years from the investment date. However, stocks and other short-term instruments must be retained for at least one year.

This article has been a guide to What is Foreign Portfolio Investment (FPI). We explain its examples, advantages, disadvantages, and comparison with FDI. You may also find some useful articles here –

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